It might help to look at who the market participants in an example market like Corn.
1) Commercial Producers. These guys grow the Corn. They have actual physical corn either in storage or in the ground that they want to hedge against adverse price movements. In other words, if it costs them $1/bushel to grow corn, and they can sell a futures contract in December against their crop at $3/bushel, that's not a bad deal for them. They are *guaranteed* that their corn will sell at $3 in 7 months when it finally comes out of the ground.
2) Commercial Consumers. These guys need corn. They may produce ethanol, animal feed, Green Giant Nibblets, export to China, or a million other things. They want to be hedged against the price skyrocketing and them losing whatever profit margins they have. If China is willing to buy in December for $4/bushel, and they can buy a December futures contract for $3/bushel, that's a guaranteed profit. The consumer does not need to worry about corn going to $8/bushel and him losing money on the deal. He also will not profit additionally if the price goes down to $2/bushel, so he needs to carefully decide when to buy.
3) Speculators. These guys (you and me, most likely) have very little interest in owning any physical corn, but want to place bets on where the price of corn will go.
If I buy a December contract at $3, I'm expecting a price rally for some reason, but someone sold it to me. It could be a commercial looking to hedge his crop. It could be a speculator betting the price will go down. The former is really an uninterested party--he doesn't care if the price goes up to $8/bushel, he's just locking in a reasonable profit for himself. The latter is making a bet I'm wrong. This dichotomy is what makes commodities so interesting.
As December rolls around, I'm going to be interested in selling my futures contract. I don't want to own corn, and any price movement I would get has already happened. There are an exact equivalent number of shorts out there. Some want to dump their short because they are a speculator, some are happy to deliver on their short because they are a commercial producer.
Spot will converge on futures because it's a simple arbitrage. You buy the futures contract and sell it on the spot market the next day when you take delivery. Any difference in price is pure (and free) profit.
The catch is this: What happens when someone buys up all of the crop on the spot market AND buys futures contracts? As expiration rolls around, the people who are short will need to also buy to get out. Who is selling? It's not the guy who owns all the long positions. It's not the commercials because they've already sold all their crop. This is called "cornering the market", and there are now tons of controls in place to keep this from happening, but it has definitely happened in the past.
In any case, your understanding of equities seems a little off too. Market Makers do not have a supply of stock sitting in their pocket and they "decide" what the price should be. The market at large has *WAAAY* more money then any Market Maker does. The MM does not set price at all--he just tries to scalp the middle.
1) Commercial Producers. These guys grow the Corn. They have actual physical corn either in storage or in the ground that they want to hedge against adverse price movements. In other words, if it costs them $1/bushel to grow corn, and they can sell a futures contract in December against their crop at $3/bushel, that's not a bad deal for them. They are *guaranteed* that their corn will sell at $3 in 7 months when it finally comes out of the ground.
2) Commercial Consumers. These guys need corn. They may produce ethanol, animal feed, Green Giant Nibblets, export to China, or a million other things. They want to be hedged against the price skyrocketing and them losing whatever profit margins they have. If China is willing to buy in December for $4/bushel, and they can buy a December futures contract for $3/bushel, that's a guaranteed profit. The consumer does not need to worry about corn going to $8/bushel and him losing money on the deal. He also will not profit additionally if the price goes down to $2/bushel, so he needs to carefully decide when to buy.
3) Speculators. These guys (you and me, most likely) have very little interest in owning any physical corn, but want to place bets on where the price of corn will go.
If I buy a December contract at $3, I'm expecting a price rally for some reason, but someone sold it to me. It could be a commercial looking to hedge his crop. It could be a speculator betting the price will go down. The former is really an uninterested party--he doesn't care if the price goes up to $8/bushel, he's just locking in a reasonable profit for himself. The latter is making a bet I'm wrong. This dichotomy is what makes commodities so interesting.
As December rolls around, I'm going to be interested in selling my futures contract. I don't want to own corn, and any price movement I would get has already happened. There are an exact equivalent number of shorts out there. Some want to dump their short because they are a speculator, some are happy to deliver on their short because they are a commercial producer.
Spot will converge on futures because it's a simple arbitrage. You buy the futures contract and sell it on the spot market the next day when you take delivery. Any difference in price is pure (and free) profit.
The catch is this: What happens when someone buys up all of the crop on the spot market AND buys futures contracts? As expiration rolls around, the people who are short will need to also buy to get out. Who is selling? It's not the guy who owns all the long positions. It's not the commercials because they've already sold all their crop. This is called "cornering the market", and there are now tons of controls in place to keep this from happening, but it has definitely happened in the past.
In any case, your understanding of equities seems a little off too. Market Makers do not have a supply of stock sitting in their pocket and they "decide" what the price should be. The market at large has *WAAAY* more money then any Market Maker does. The MM does not set price at all--he just tries to scalp the middle.
